Monday, June 13, 2011

Edward Steves and his Million Dollar Gold Arbitrage: A Lesson in Wealth Preservation

During the Civil War, an independent thinker from San Antonio named Edward Steves made a savvy business move that would forever change his fortune and that of his family for generations. He made a bet against a dying currency in favor of the only currency that has never failed.

In Texas, truth and myth are often blurred, as stories of what the human spirit accomplishes are stretched into tall tales for open camp fires and star filled nights. Perhaps the story of Mr. Steves borders on exaggeration. Perhaps not. In either case, the moral offers a profound lesson in wealth preservation and accumulation.

Steves immigrated to the United States in 1849 from Barmen, Elberfeld, Germany. He ventured into the Texas hill country as a farmer with mediocre success as he battled unpredictable weather, threat of local Indians, and rocky soil. He scraped every penny; and in early 1861, with an entrepreneurial spirit as big as Texas, he spent his entire savings on a newly invented machine – the first mechanical combine to make it to the South Central Texas region. As fate would have it, this machine arrived on the last ship to make it into Galveston, Texas before the Union blockaded the port in July 1861. After his mechanical contraption arrived in San Antonio, Steves had a monopoly over the local farmers surrounding the area.
The farmers wanted to pay Steves for the use of his mechanical combine in the local currency, Confederate dollars. He refused. He negotiated to take his payment in kind – a percentage of what his combine would process. Steves then bundled up his portion and regularly set off for Mexico, where he would sell it for gold and silver. This occurred for several years until finally the Civil War ended. The Confederacy collapsed along with the monetary system. Confederate dollars and Confederate bonds became worthless, sending many individuals into financial ruin.

The end of the Gavelston blockade marked the death of his monopoly, but by that time he had amassed a fortune in gold and silver. With this fortune, he bought Union dollars and effectively bought back into a working economic system. In 1866 he launched a lumber company that by 1916 had become the largest millwork operation in the Southwest. It exists today as Steves & Sons, offering more than 300,000 variations of doors throughout the United States.

In today’s world most individuals, including investment professionals, have very little understanding of the history and purpose of precious metals as a monetary asset. Monetary systems have come and gone for thousands of years, but our lives are so cloistered that the probability of living through two entirely different monetary systems seems highly unlikely. As the Steves story illustrates, even in the United States monetary systems collapse and evolve.

The impetuous drive towards globalism and a “world currency” may impact our monetary system more than even the national debt. Initially, the evolution of a system brings chaos. People cling to staples . . . land, guns, and food production. As a new system emerges, individuals who have precious metals maintain the capacity to buy back into the new system - buying a home, starting new businesses, regaining the quality of life of the previous system. After 5,000 years, this continues to remain the ultimate benefit of precious metals. The irony is that a true global currency has always existed in the form of gold and silver.

Unless an investor trades precious metals effectively, which very few can do over a long period of time, precious metals do not generate wealth in a functioning economic system. Gold is a store of wealth not a generator of wealth. It is much better to own thriving companies that produce a superior return over their cost of capital. Owning businesses that generate a superior return on invested capital is the way to move up the social status in a functioning capitalist system. Unfortunately, American capitalism has been compromised and is now sputtering.

Ten years ago I would have argued that the probability of an American monetary collapse over the following decade was zero. The next ten years present far less certainty. One may disagree whether the probability of a collapse over the next ten years is 2%, 25%, or 60%. But the probability is no longer zero. The criticality of gold and silver as an asset class has reemerged. The Edward Steves story is an illustrative parable of how to build and preserve wealth when economic systems are in flux.

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